Was Osborne right to prioritise fiscal balance in 2010?

This essay examines Mr Osborne's decisions and actions in terms their economic and social impacts on the UK.

Fiscal stability, along with economic growth, low unemployment, low and stable inflation, a balance of payments, more equal income distribution and environmental protection, is one of seven macroeconomic objectives. No economy is able to achieve all seven at the same time, because in pursuing one of them, another, ceteris paribus, would have to be sacrificed. For example, to continue higher economic growth, often demand-side policies are required to be implemented, which would lead to aggregate demand rising faster than supply. This would push up prices of scarce resources, causing higher inflation. Therefore, the need to prioritise macroeconomic objectives arises. Prioritising fiscal balance through the policy of austerity was Mr Osborne’s effort of reducing the UK government deficit. However, in doing so, Mr Osborne sacrificed pursuing economic growth.

The OBR has estimated that approximately 2% of the UK’s GDP was lost due to austerity. The supporters of austerity would claim that the recovery Britain witnessed since 2010 was caused by austerity. They would point to the fact that the UK recovered faster than the majority of other European countries. Furthermore, they would argue that the reduction of the government deficit increased the confidence of both domestic and foreign investors, which led to an increase in investment into the UK economy, resulting in turn to growth in both aggregate demand and aggregate supply. What’s more, prioritising fiscal balance has helped the UK to keep its AAA credit rating, which held interest rates on the UK government bonds at only 2%. In other words, austerity helped the UK government to keep its borrowing costs low. Finally, they would point to the fact that between 2010 and 2015, the UK unemployment rate fell from 7.9% to 5.21%. This drop in unemployment has led to an increase in aggregate demand, as the previously unemployed now had incomes and could make more purchases, which led to economic growth and thus contributed to the recovery.

I believe these arguments are flawed. Firstly, in 2013, Moody’s had downgraded the UK credit rating from AAA to AA1. In fact, not only did the UK lose its credit rating – making the argument that austerity has helped Britain to keep its credit rating factually incorrect – but Moody’s indicated that its decision to downgrade came from their opinion that continuing austerity would result in a “bleak outlook” for the UK’s economy due to a lack of government spending. Even after Moody’s published its decision, the cost of borrowing for the UK government did not rise. This was not due to austerity; the majority of the government bonds are held by the Bank of England, meaning a massive sell-off of the UK government debt would not have been possible. Similarly, the significant decline in the unemployment rate was not due to austerity. Between 2010 and 2012, the unemployment rate stayed level, suggesting that factors other than austerity were the causes of the drop in unemployment after 2012. For example, an increasing number of unemployed people started taking zero hour contracts. In fact, there were as many as 700,000 zero hour contracts in 2012. Furthermore, even if austerity helped the British economy to recover, not much of recovery took place. Professor Jon Van Brennen of the London School of Economics has labelled UK’s recovery as “the worst recovery in this century.” He argues that, in comparison to the historical trends, GDP per capita was 16% lower in 2014, which amounts to a loss of around 4,500 pounds. Furthermore, UK productivity is 14% below the long-term trend and 17% below the G7 average. Finally, any economic recovery which did take place occurred in spite of austerity, not because of it. The 2008-2009 crisis was a financial one and, unlike other European economies, the UK economy was mainly orientated on the export of financial services. As a result, the UK economy was one of the hardest hit by the financial crisis in Europe. In other words, the UK fell deeper into its PPF than most other European countries, meaning a faster economic growth, measured in percentage change of GDP, was easier to achieve. Another factor, which contributed to the recovery, was a favourable macroeconomic climate. Faster population growth, caused by high net migration into the UK, added to the GDP growth rate of 2.7% in 2014; it increased aggregate demand by increasing the number of consumers in the economy and increased aggregate supply by decreasing the dependency ratio – the majority of migrants were young job seekers from Eastern Europe and Asia. Low fuel prices also increased aggregate supply by reducing the cost of production. The Olympics, which took place in London in 2012, raised the aggregate demand mainly due to a rise in exports, such as tourism. However, the most significant factor behind the UK’s recovery was an expansionary monetary policy adopted by the Bank of England, which increased the aggregate demand by reducing the cost of borrowing for firms and devalued the pound, making British exports more competitive.

Trends show that austerity increased the level of poverty in the UK. It caused an additional 800,000 children to be living in poverty, caused a significant rise in homelessness, put an extra 1.3 million working-age adults on the brink of relative poverty and, according to the Institute for Financial Studies, is set to increase absolute and relative poverty by 2020. Furthermore, austerity contributed to the long-term growth of unemployment. By 2020, unemployment is projected to grow 0.3%. Austerity decreased the chances of the unemployed climbing out of unemployment as the unemployed have experienced a 7% loss of income. Austerity was also divisive. It increased the income inequality gap, which has risen faster among the working-age population than in any other OECD country. According to Oxfam, as a result of the austerity measures, the poorest 10% of the population “have seen greater cuts in their net income…than every other group, except the very richest tenth”.

Austerity was a misguided policy to be adopted in 2010. Even the United Nation’s Committee on Economic, Social and Cultural Rights has confirmed that “the UK government’s austerity measures are in breach of their obligations to human rights.” Instead of prioritising fiscal balance, Mr Osborne should have issued more government bonds and used this money to increase government spending in the economy (just as Philip Hammond has recently done by announcing an 80 billion pound house building scheme). This would have lead to economic growth and a rise in inflation, which would have made it easier to pay back the interest on the bonds he would have issued in the first place.